The ESG opportunity in Europe

The European Union launched a serious bid in December 2019 to become the world’s first climate-neutral continent by 2050. The European Green Deal was introduced as a bold initiative that promised to “provide a roadmap with actions to boost the efficient use of resources by moving to a clean, circular economy and stop climate change, revert biodiversity loss and cut pollution.”

It was – and still is – a serious statement of intent. It establishes practical steps and a legislative framework, focuses on the investments needed, and also bolsters the financing tools available. Underpinning it is a commitment to ensuring “a just and inclusive transition”.

Two and a half years later, the EU Green Deal remains a major focus of the EU, but awareness in the business community appears to be low. According to PWC’s European Green Deal Survey conducted late last year across 13 EU countries, a majority of businesses in the region are unfamiliar with the detail of the EU Green Deal (60%), and fewer than half (49%) say that they are prepared for it.

However, green shoots exist: two thirds of the businesses surveyed said that they had allocated funds to invest in becoming more sustainable in the next three to five years, and the survey also found that companies were taking the challenge seriously of consuming “more clean energy (78%), reducing energy consumption (60%), reducing waste and plastic use (59%) and cutting carbon emissions (59%)”.

At Ashurst, this is a trend we’re seeing repeated across the region. Among the institutional investors we work with, for example, there is an appetite for ESG principles, with policies embraced that enshrine ESG commitments and ESG-related investment funds. Europe is leading the way, with 81% of the $2.7 trillion invested in global exchange-traded ‘sustainable’ funds residing in the region, according to a recent study by Harvard Business Review.

Much of the focus of these ‘sustainable’ funds is around climate-related activities, although the social impact of ESG investments is also on the rise. A recent survey of pension funds in the UK by Pensions for Purpose, a social impact investment consultancy, found that at least half hold investments that have some form of social impact – representing almost 5% of the £150bn assets they manage. The survey highlighted that the majority of social impact investments (78%) fall firmly in the social infrastructure space – hospitals, schools, student accommodation, for example – closely followed by social and affordable housing (44%). This is a trend being repeated across the region.

These are no longer “lip service” topics. In fact, very real progress is being made – both at a national and a European level – towards taking serious steps to reduce carbon footprints, to make ethical investments, and to proactively prepare for the time in the not-too-distant future when carbon neutrality will be a mandated requirement, rather than a nice-to-have.

According to Eleanor Reeves, a partner in Ashurst’s London office, the ESG investment umbrella doesn’t just help set a critical pathway to net zero emissions, but it also ensures a just transition through environmental and social improvements. “Although there has been a rise in social impact funds under management over the last decade, 5% is still relatively small, and one of the barriers to expanding social impact funds under management is that metrics for real estate-focused social impact are underdeveloped,” she says. “However, it’s clear that prioritising people and places can be profitable and market-led, as we see from initiatives to scale up institutional investments such as the UK place-based impact investing project led by The Good Economy, the Impact Investing Institute and Pensions for Purpose.”

Andrea Caputo, a partner in Ashurst’s Italian practice, says: “When I speak to my colleagues in countries like Spain, Germany and France, there is definitely a European view of these themes that emerges. Absolutely, every country has its particular legislation and its own way to develop, to improve these trends. But in the end, there is a drive within the European Union to create a new real estate market, with greater attention being paid to the green economy and to ESG themes.”

Progress will require a partnership, however, between the public and private sectors. Cristina Calvo, who is a Partner in Ashurst’s Spanish business, has seen first-hand how important this partnership is. “In Spain, there are lots of empty words being spoken about the government’s 2030 sustainability agenda, which is very ambitious but largely unachievable”, says Cristina. “Politicians need to move beyond empty words and actually embrace green and sustainable policies.” Change will actually be driven by the private sector, from large corporations and from their commitment to sustainability. “Large corporations recognise that it’s necessary and that it is a ‘good thing’, because we want to leave our children with a better world. They also recognise that they can’t afford to be left behind and not be seen to be doing this. This ‘carrot and stick’ approach is what is driving forward change,” says Cristina.

There’s another major driver for continued change, namely the need to stimulate national economies in the aftermath of the COVID-19 pandemic. Italy’s linking of its tax credit system to building renovations that significantly improve the energy efficiency and performance of buildings is a case in point, where tax credits of 110% can be applied against the cost of such building improvements. In France, the new climate resilience law (Le Loi Climat), established a framework for a zero carbon future adopted in August 2021. But it is initiatives such as the ‘Decret Tertiaire’ which may provide the biggest stimulus for change. This gives notice to France’s services sector that it must reduce energy consumption by 40% by 2030, by a further 50% by 2040, and a further 60% by 2050.

This is a significant challenge, and it is one that will be replicated across most of Europe’s capitals. In London, for example, the availability of commercial energy-efficient real estate is lacking, with demand far outstripping supply. Given that as much as 80% of the commercial real estate that exists today in London will still be in use by 2050 – the deadline by which net zero targets are being set – upgrading the energy performance of today’s building stock is a major priority.

The industry will need to wrestle with some significant challenges to meet these targets. As a whole, the European Region is lacking information on the costs of meeting such targets – and agreeing who pays for them. The resulting tensions between landlords and tenants are having an increasing impact on lease negotiations, with green lease provisions being increasingly used. Investment funds are also increasingly insisting on KPIs being set in the contract stage, and are appointing independent third parties to ensure that those KPIs are being met.

It’s important that this new level of scrutiny does not hinder innovation or introduce unnecessary bureaucracy for those looking to make progress in ESG investments. But it is also perhaps a sign that the market is beginning to take social impact investments seriously. If you invest in ESG, you are probably going to be more competitive in the marketplace. You will attract finance, buyers, and tenants for your developments. And you are far less likely to run the risk of having a stranded or distressed asset, once energy efficiency performance becomes mandatory. ESG and social impact investing should definitely lead to an increase in value, and create more appetite for investing in the building stock of the future.

Authors: Eleanor Reeves, Partner; Andrea Caputo, Partner; Cristina Calvo, Partner; Liane Muschter, Partner